{"id":11567,"date":"2019-04-18T14:37:19","date_gmt":"2019-04-18T18:37:19","guid":{"rendered":"https:\/\/hamiltonetfs.com\/?p=11567"},"modified":"2020-07-06T13:42:47","modified_gmt":"2020-07-06T17:42:47","slug":"canadian-banks-why-volatility-will-likely-rise","status":"publish","type":"post","link":"https:\/\/hamiltonetfs.com\/canadian-banks-why-volatility-will-likely-rise\/","title":{"rendered":"Canadian Banks: Why Volatility Will Likely Rise (and a Comment on Mean Reversion)"},"content":{"rendered":"

In October 2018, we launched the Hamilton Capital Canadian Bank Variable-Weight ETF (ticker: HCB)<\/strong>, which seeks to benefit from the historical mean reversion tendencies of the Big-6 banks, especially in times of greater market volatility. At the end of each month, the three most oversold banks are rebalanced to represent ~80% of HCB<\/strong>, while the three most overbought banks are rebalanced to 20%. HCB<\/strong>\u2019s objective is to \u2013 over time \u2013 generate higher returns with lower volatility relative to an equal-weight basket of the Big-6 while providing monthly dividends.<\/p>\n

Note to Reader<\/strong>: This Insight includes references to certain Hamilton ETFs that were active at the time of writing. On June 29, 2020, the following mergers took place: (i) Hamilton Global Financials Yield ETF and Hamilton Global Bank ETF into the Hamilton Global Financials ETF (HFG)<\/strong><\/a>, (ii) Hamilton Australian Financials Yield ETF into the Hamilton Australian Bank Equal-Weight Index ETF (HBA)<\/strong><\/a>; (iii) Hamilton Canadian Bank Variable-Weight ETF into the Hamilton Canadian Bank Mean Reversion Index ETF (HCA)<\/strong><\/a>, and (iv) Hamilton U.S. Mid-Cap Financials ETF (USD) into the Hamilton U.S. Mid\/Small-Cap Financials ETF (HUM)<\/a>.<\/strong><\/p>\n

We believe that in the next two years the Canadian banks are likely to experience higher volatility. This could be beneficial to HCB<\/strong> since the benefits of mean reversion have historically been greatest in periods of heightened volatility.<\/p>\n

Why do we expect volatility for the Canadian banks to increase?<\/p>\n

First<\/u><\/strong>, acquisition risk is rising for those Canadian banks with U.S. commercial banking platforms<\/strong>, specifically, BMO, RY, CM, and most importantly, TD. Recent high profile bank mergers south of the border suggest that, after several years of limited activity, U.S. bank M&A (of size) is poised to accelerate. Given the immense strategic significance of their U.S. expansion strategies, the Canadian banks with U.S. platforms (combined commercial bank assets of over US$500 billion) will likely feel pressure to continue building these platforms through acquisitions.<\/p>\n

In the last 20 years, one constant in bank valuations has been the tendency for multiple compression\/volatility post large acquisitions. It is very easy to envision an acquiring bank losing 0.5x-1.0x of its relative price-to-earnings multiple after announcing a larger transaction. Last year was a good example; BNS underperformed its peers, primarily in response to its Canadian wealth management acquisitions1

Today, we believe TD is most at risk, given its lower quality Southeast platform (largely built through the acquisition of failed\/failing U.S. banks), higher capital ratios (signaling preparation for a deal), and the fact it has not done a U.S. commercial bank acquisition in the region since 2010. However, BMO, CIBC and RY are also potential acquirers thereby increasing acquisition risk.<\/p>\n

Second<\/u><\/strong>, the change in accounting for loan losses is likely to create additional volatility \u2013 both upside and downside<\/strong>. To simplify, the banks transitioned last year from an \u201cincurred loss\u201d model (i.e., report losses when<\/em> they occur) to an \u201cexpected loss\u201d model (i.e., book estimated losses before<\/em> they occur)2

Last quarter was instructive as the size and breadth of the step-up in loan losses for the overall sector was a surprise to the market. Loan losses are one of the two most important drivers of volatility in bank earnings (the other is capital markets). Reduced visibility in this critical expense will very likely make it more difficult for analysts to forecast quarterly EPS, increasing the probability of beats\/misses and resultant share price volatility.<\/p>\n

If either or both of these issues create volatility \u2013 and mean reversion persists \u2013 this could favour the Hamilton Capital Canadian Bank Variable-Weight ETF<\/strong> over an equal-weighted portfolio of Canadian banks.<\/p>\n

____<\/p>\n

A word on trading liquidity for ETFs <\/em><\/strong>…<\/p>\n

HCB<\/strong> is a highly liquid ETF that can be purchased and sold easily. ETFs are as liquid as their underlying holdings and HCB<\/strong> holds the Big-6 Canadian banks, all of which are highly liquid stocks, trading millions of shares each day.<\/p>\n

How does that work?<\/strong> When ETF investors are buying (or selling) in the market, they may transact with another ETF investor or a market maker for the ETF. At all times, even if daily volume appears low, there is a market maker \u2013 typically a large investment bank \u2013 willing to fill the other side of the ETF order (at net asset value plus a spread). The market maker then subscribes to create or redeem units in the ETF from the ETF manager (e.g., Hamilton Capital), who purchases or sells the underlying holdings for the ETF.<\/a><\/p>\n

\n

Related Insights<\/strong><\/em><\/p>\n

Canadian Banks: Mean-Reversion Strategy for Higher Returns\/Lower Risk<\/a> \u2013 September 27, 2018<\/p>\n

Cdn\/Aust\u2019n\u00a0Banks: Why the Big Housing Short is So Difficult (and the Risk of a \u2018Direct Hit\u2019 Remains Low)<\/a>\u00a0– April 9, 2019<\/p>\n

Canadian Banks: Five Takeaways from BBT\/STI, Accelerating U.S. Bank M&A<\/a>\u00a0–\u00a0February\u00a011, 2019<\/p>\n

Pref ETFs Falter (Again): Why HCB\/HFA are Logical Switch Candidates for Monthly Income<\/a> \u2013 December 17, 2018<\/p>\n

\n

Note: Comments, charts and opinions offered in this commentary are produced by Hamilton Capital and are for information purposes only. They should not be considered as advice to purchase or to sell mentioned sec<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

In October 2018, we launched the Hamilton Capital Canadian Bank Variable-Weight ETF (ticker: HCB), which seeks to benefit from the historical mean reversion tendencies of the Big-6 banks, especially in times of greater market volatility. At the end of each month, the three most oversold banks are rebalanced to represent ~80% of HCB, while the three most overbought banks are rebalanced to 20%. HCB\u2019s objective is…<\/p>\n","protected":false},"author":10,"featured_media":11573,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_custom_body_class":"","_custom_post_class":"","content-type":""},"categories":[5,9,34,41],"tags":[],"_links":{"self":[{"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/posts\/11567"}],"collection":[{"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/users\/10"}],"replies":[{"embeddable":true,"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/comments?post=11567"}],"version-history":[{"count":0,"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/posts\/11567\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/media\/11573"}],"wp:attachment":[{"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/media?parent=11567"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/categories?post=11567"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/hamiltonetfs.com\/wp-json\/wp\/v2\/tags?post=11567"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}